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Why should I invest outside the US?

Don’t put all your eggs in one basket. We’ve all probably heard the old idiom warning against the danger of committing all your resources into one area. If you wouldn’t make a concentrated investment on one single stock, why would you limit your investment opportunities to just one country?

The US stock market is the biggest in the world(1), making up 57% of world equity market capitalization. Our domestic market represents 3,655 companies and $42 trillion(2.) While that is significant, if you limit your investments to the US, you will miss out on the 7,418 companies in the developed ex us market and 8,716 companies in emerging markets(2).

Population size and GDP may not be the most important factors when considering where to invest. For example, Japan is relatively small when looking at landmass, but the country accounts for 7% of the world’s equity market value and includes many familiar names like Sony and Toyota(2). Sweden outperformed the US in 2020 and is home to many companies we enjoy like Spotify, Volvo, H&M, and of course, IKEA(3).

There’s no evidence that one or a few specific developed countries are expected to outperform. The table below, in which each color represents one of 22 developed countries over 20 years, shows just how random country returns can be. The scattered colors suggest it is nearly impossible to predict which country will be at the top from one year to the next.

Would you have predicted 20 years ago that Denmark would be the top performer in developed markets? From 2001-2020 Denmark experienced annualized returns of 11.7%, while the US had annualized returns of 7%(3). That’s not to say you should now go all in on danish companies, but rather, a globally diversified portfolio would have been positioned to capture those returns.

Just because a country does well one year does not mean it will continue to outperform the next year. For example, Austria experienced the highest returns for developed markets in 2017 but fell to the worst performer in 2018(3).

Over the past few years, US stocks have outpaced international and emerging markets. But just because US stocks have outperformed non-US stocks recently does not mean that these short-term returns are reliable indicators of future.

Recent performance may lead some to forget the “Lost Decade” from 2000-2009, in which the S&P 500 had a total cumulative return of -9.1%(4). However, the investment experience was much more favorable for those with a global opportunity set. The MSCI World ex US Index (net div.) had a total cumulative return of 17.47% and the MSCI Emerging Markets Index (net div.) returned 154.28%(4).

Headlines may warn about investing in other countries for one reason or another based on the crisis of the day. Recently, the attention has circled around the vaccine rollout globally. However, expectations around a country’s future risks and rewards have already been incorporated into market prices.

There is not a definitively “correct” amount of exposure outside of one’s own country. For tax-deferred investors in the US, some home bias may make sense due to foreign dividend tax withholdings. But it is important to keep in mind that limiting your opportunity set may increase risks and decrease the benefits of diversification.

Concentrating a portfolio to any one country can lead to large variations in returns. A global opportunity set can help provide a more consistent investment experience. By diversifying, you can reduce the devastating losses associated with investing in just a handful of stocks or a single country.

How do you avoid getting egg on your face? Diversify. Diversification across companies, sectors, and countries increases your reliability of outcomes and can help capture a broad range of returns.

Past performance is no guarantee of results. In USD. MSCI country indices (net dividends) for each country listed. Does not include Israel, which MSCI classified as an emerging market prior to May 2010. MSCI data © MSCI 2021, all rights reserved.

 

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